Is it smart to buy real estate in lieu of 401k and IRA?

Question

I want to buy a 2nd home in New Hampshire for investment and vacation purposes. But, to afford it, I will need to cut back on future contributions to 401k and IRA. I am 40 years old, and currently contribute about $30,000 to retirement accounts per year. The way I figure it, if i get 7% on the $30K, retirement that's $2100. If I take that same $30K and use it for down payment and mortgage expense on a $200,000 house that returns 7% that's $14,000. Plus in this market I am losing 10% on retirement savings - my thought is go to cash for 6 months, save some $ for down payment and buy when RE market is very soft. Thoughts?

Answer 1

Diversification is smart. Be careful to model the best case, expected case, and worse case scenarios for the second home. What happens if you buy it and you can't rent it out? Can you carry it? For how long?

What about upkeep, insurance, and all the other headaches of homeownership? These things take time as well. You don't have those headaches with a mutual fund or a real estate ETF or REIT.

You can benefit from the soft market in real estate by buying a REIT and you don't have to waste a weekend fixing up your 2nd home.

Just food for thought.

Answer 2

except 2 things...you're not going to get 7% over time on housing (as this current market should tell you).   Historically, housing has run 5-6% returns while the stock market has returned 9-11%.  Nor are you considering the interest of 7% that you would be paying on that loan.   You're also not taking into consideration taxes and fees for selling or upkeep on the home in the interim.  And most importantly  you are not taking into consideration the possibility of an extreme down market (such as we are in) when you need to sell the house.   Certainly you can wait for it to turn around but 1) the equity markets turn quicker than housing and 2) You can still draw small sums from the equity markets without killing your account.  With half of your retirement in the real estate market you're risk exposure is HUGE because it's an all or nothing thing.

It's all about diversity my friend...and if you have to cut back on ANYTHING in order to buy that home then you are not diverse enough in your holdings.  Think of it this way....when you're 65 would you put half of your retirement into a single stock?  Likely not...then why do it here?

Answer 3

I think diversifying is always a good thing.  How much you will be taxed on the additional $30,000 is something to think about, especially if it moves you up to a higher tax bracket. Of course there will be the mortgage interest tax savings, if you itemize your taxes. I would let your accountant crunch the numbers for you. Seems like a good idea to me though. Never been to New Hampshire, but I hear it's beautiful.

Answer 4

What matters is your tax bracket.  Your retirement money grows tax deferred and may be invested before taxes.  You're going to have to get more on a taxable investment than you would on your retirement funds to justify investing in a taxable investment,  Probably around 10-11 percent in the 28-33 percent tax bracket.

Answer 5

I don't think you can contribute that much to a 401K

Answer 6

Property values and stock prices both go DOWN as well as up....stock prices have a longer record of consistent rises over appropriate lengths of time than do property prices (in the US).

Since you are 40 years old, you are looking at a 30-year time horizon; unless the next 5 years bring a flurry of construction that fills up all the remaining real estate in the US, 30 years from now a $30,000 well-balanced portfolio of stocks is all but guaranteed to be worth more (about $500,000)  than $30,000 of real estate purchased at todays prices (about $150K-$200K).

Historically, the average long-term return on stocks is 9-10% a year.

The average long-term return on real estate is 3-4% a year.

THink about the math: cutting back on your retirement contributions now will "lock in" your losses! Very silly indeed!

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